Tuesday, July 26, 2016

CNXC Today

The reason CNXC is up so much today was the earnings report and call. Not only were the numbers good, but management's commentary on the coal situation was quite optimistic. In fact, it pretty much followed the analysis I laid out in the previous post. They also will continue the distribution at the rate of .51 per share for the time being. There will be no distributions to the subordinated holders (these are mostly CNX Energy), although they hope to resume that.
So everything is on track. The next big item is political. Once the DNC convention is over, we will have to see which way Hillary goes. If she keeps veering left and depends on attacking Donald, it will be bad for coal. If she moves to a more centrist policy and a positive campaign, it means she is going to fight for Pennsylvania. That's good for coal, and might be a good sign for how the Clean Power Plan will be implemented if it survives court challenges.

Friday, July 22, 2016

Nickle Victory Lap

I took off my nickel metal position today, but kept my Norilsk equity. Apparently quite a few others had the same idea since it finished down over 3%.

This was my biggest position in a while, and some of my friends thought I was too early. This is a good example of strategic commodity investing. So let's go through it again.

The spark for the trade came from the 10-year graphs. Nickel was the most undervalued metal in the world I follow. On a closer look, I saw the cost curves put out by the sell side and some consultants. Most of them had about 75% of production losing money. That can't last forever, right. Ok the value is there, but what about the catalysts? Where will they come from? That is what the naysayers meant.

The key here is that if the value is there, and the cost of carry is small, you can wait it out. I truly did not know what was going to make nickel go up, but I knew something eventually would. As it turned out, it was something that neither I nor most others thought would happen. A populist was elected in the Philippines and cleaning up mining pollution is one of his populist ideas. If you had asked me (or probably and other investor) if this could happen, I would have probably said no. The Philippine government was in bed with the mining industry. But it did happen, and the upside was about 35%.

Nickel is still undervalued, but less so. There's a lot of nickel ore on the earth. The Chinese may have to pay a little more for it, but they will get it. Don't expect the Chinese NPI industry to shut down or even contract much. That's not the way China works. They don't shut stuff down; they funnel money into it one way or another. I noticed that they just made a deal with the miner in New Caledonia.

So I don't think the risk/reward of holding nickel and paying carry here is worth it. But Norilsk works the other way. It has a 4% dividend. That I can wait with.

Monday, July 18, 2016

The Coal Turnaround

I've taken positions long thermal coal companies. I've gone long CNXC and increased my positions in the defaulted debt of US coal companies. I'm also considering South32. I am not buying the commodity itself.

Times are very very bad for the US coal industry. I think readers of this blog will know why:
- The new technology of fracking has led to much lower natural gas costs. Natural gas competes directly with coal as an input to electricity generation.
- The Obama administration has encouraged this switch in the hope of reducing CO2 emissions, although the percent of world emissions saved is miniscule.
- The industry itself increased its leverage in the years prior to the decline, and has not had the resources to retrench.
- The collapse of LNG prices in Asia, has hurt the coal export market. Here's a graph from the Wall Street Journal of the Asian price.

The result of this is that all coal prices have fallen sharply. Here's a nearest futures continuation graph from barchart.com of Eastern US coal:

And here is a similar chart of coal CIF Rotterdam area. This is a good proxy for the world export market:
I believe the little upmoves in the right hand side of these charts are not fakeouts, but are the end of the long declines. Here's my argument:

The US coal industry extended its leverage in the years leading up to the bust. For example in 2008, at the height of the financial crisis, Peabody Energy had a liabilities to assets ratio of .67. As of the last financial statement before Chapter 11, it was .92. Some of this was operating losses, but a large part was a 42% increase in debt. The company simply did not have the financial flexibility to hunker down when times got very tough.

The situation was exacerbated by the failure of the industry to cut back production when the writing was on the wall. The combination of declining consumption and stable production has led to a very big increase in coal inventories. Here's a chart from the US EIA of coal consumption and stocks. Note that this ends in March 2016. I explain below why I think this has since turned around. Data is in 000 tons.

OK. That's the bad news background. Here's why I think things are turning around.

Recent data on coal railroad loadings has gotten better. This chart is from the American Association of Railroads:

You can see how coal loadings finally turned down in late 2015 and early 2016. Recently it has moved up, although not to earlier levels. This is consistent with a story of production cutbacks to a level which start to reduce inventories. However, railcar loadings and production are not likely to get back to earlier levels for a long time, if ever.

Natural gas prices have moved up. This directly impacts coal since a large number of powerplants have dual fuel capability and will chose whichever is cheaper. Here's a chart of August 2016 gas futures:

Weather has a surprising effect on coal demand (surprising to me anyway, since I thought coal was mostly used for baseline generation). In fact, analysts I have read put part of the blame for low coal consumption on the mild winter. So far Spring has been hot in much of the sunbelt. It hasn't been cool anywhere.

The result of this has been strengthening in coal prices. We saw this in the earlier charts, but it is important to know that the futures market is forecasting even higher prices for some coals, particularly eastern US.

      ICE CSX Coal
Aug 2016    40.20
Aug 2017    47.25

Since production costs may actually decline a little over the next year, this will be a big boost to cash flow.

So it looks to me like a typical commodity "cobweb" turnaround is happening right now. There is one big risk however. The Obama administration has proposed a new set of rules, the Clean Power Plan. This would sharply limit how much coal can be burned. They did this by regulatory action since they know that it could not be done legislatively. Much like the recent administrative action on immigration, this is being challenged in the courts. It is currently before a Federal Appeals Court. If this is upheld, it will be a huge long-term negative for the industry and a short term blow similar to Brexit was to the Pound. The ruling could come soon.

If you are willing to accept this risk, there are many assets you could buy. Probably the easiest is the ETF KOL. This is an ETF of coal miners, suppliers and transporters. However, it is not US focused. Several of its largest holdings are Chinese, and its largest holding, Teck Resources (TCK), does a lot more than coal.

If your tax situation is appropriate, the MLP CNXC should be considered. It was spun out from Consol Energy. David Einhorn, who owns much of Consol, wants it to concentrate on its gas E&P operations. Einhorn still owns much of CNXC, but I would expect him to sell on strength. Right now it's dividend rate is about 20%. However, only about 40% of that is covered by income, so I expect some reduction.

Finally, if you are willing to take on high risk and you want upside optionality, consider the bonds of the defaulted coal companies. For example, Peabody Energy bonds are going for about twelve cents on the dollar. If the coal market does righten itself, and if the Chapter 11 proceedings are not closed too quickly, these could be worth much more than that.

Thursday, July 14, 2016

Back from a long hiatus...

The updated long-run strategy graphs are online.

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These are a key part of my process. They are a great screening tool.